Educational Articles

Coverage Initiation: Skullcandy

Reuben Gregg Brewer
| November 07, 2011

Value Line has initiated coverage of Skullcandy (SKUL) in The Value Line Investment Survey. The company’s prospectus boldly states, “Our brand symbolizes youth and rebellion, and embodies our motto, ‘Every revolution needs a soundtrack.’” These words are important, as they suggest larger aspirations from a company that got its start making “cool” headphones.

Skullcandy was founded by Rick Alden in 2003. This proved an opportune time, as products, primarily Apple’s (AAPL) iPod, that allowed for the portability of high-quality music were just beginning to gain steam. Initially, the company sold highly stylized replacement headphones, focusing on the youth and sports-oriented markets. Although it sells products along a large price spectrum, until recently, the main range was between $20 and $70.

The company’s products are largely commodity like items. The difference is that Skullcandy has, so far, been able to add value to its products through its branding strategy. They describe this in their prospectus as “revolutionary”, which time will likely show is little more than hyperbole. That said, Skullcandy has clearly been able to add cache to otherwise boring products. Management believes that, at the end of 2010, it held the top position in the ear-bud category and the number-two position in the headphone arena, behind Sony (SNE), based on unit and dollar sales.

Part of the company’s branding involves both the image of its products and where they are sold. Although now available at mass merchandisers, such as Best Buy (BBY), the company has historically focused on youth and action sports-oriented specialty stores. In addition, the company has sought out sponsorship deals with select athletes and artists that it believes will help to further its brand image, as well as sponsoring specific sporting events that fit its “edgy” image.

Today, Skullcandy sells its products in over 70 countries around the world (foreign sales represented just under 20% of the total in 2010) in a vast array of stores, including mass merchants, sports retailers, youth-oriented stores, and mobile phone stores, among others. It is also bringing out more expensive headphone products, including the recently introduced “Aviator” and “Mix Master” models that cost up to $250. Penetrating the higher-cost headphone market is just one avenue of growth the company is pursuing, however.

It is looking to increase its market share in the U.S. market, expand its market share overseas, and, interestingly, broaden its product portfolio. While the first two would seem obvious, as would offering higher-cost products, the last is the most risky, but potentially the most rewarding. Indeed, since the company already has a material share of the headphone market, growth in this business is likely to be limited over time. The company notes that it intends to sell speaker dock models, increase its offerings of protective cases for mobile devices, and introduce gaming and mobile phone headphones. Clearly, it is expanding beyond replacement headphones, but doing so in a way that appears to keep within its core strengths. That said, it also sells branded clothing and accessories, which furthers the brand, but veers away from the core effort.

The company is also trying to garner brand loyalty, and product sales, through the Internet. Thus, the company’s website offers customers content, connectivity, and an avenue for purchasing Skullcandy branded items. Management hopes to push this avenue of sales, which would be higher margined than sales through other retailers, as a means of growth. Web sales represented just over 5% of sales in 2010, suggesting that there is some room for expansion here, assuming the company can create compelling enough reasons for consumers to visit.

In the end, Skullcandy is more about brand than product. This is a benefit while its image is gaining traction and is viewed as “cool.” However, mismanaging the brand could lead to material repercussions on both the top and bottom line. Should Skullcandy lose its cache, every product it offers would be tarnished—not just its headphones. In fact, overextending the brand through new products or making products available through too many sales channels, could lead to customer dissatisfaction. Thus, managing the brand image is paramount for the company—though this is little different than many other brand-oriented business from toothpaste to automobiles.

Since the company makes extensive use of sponsorships, its brand image also encompasses these relationships. This includes the risk of sponsoring someone that, ultimately, turns out to be less than desirable as a business partner because of actions taken subsequent to the sponsorship. This could include poor performance for sports figures, weak sales figures for musicians, or outright harmful personal events, such as criminal acts.

Although the company sells items through a large number of stores, Target (TGT) and Best Buy are both material to the company’s sales efforts. The loss of either could materially affect results. Moreover, it has two manufacturer relationships that account for the majority of its products. If either of these relationships were to end, or if either company were to experience production disruptions, sales and earnings would likely be hurt.

In the end, although the company is far from mature at this juncture, it is unlikely that Skullcandy can continue its sales growth at historical rates. Moreover, as a public company, its initial public offering was held in mid-2011, it faces the costs and complications of being a public company, which will likely weigh on margins. Still, as long as management can keep the “cool” factor going, Skullcandy appears to be in a growth phase. Shareholders can keep track of the company’s progress by reading Value Line’s regular updates in The Value Line Investment Survey.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.